Tag Archives: SEBI Act

It is raining ex parte orders again in the Indian securities market. Essentially, orders that are passed without hearing the person against whom it is passed, the practice is justified in the eyes of the law if the circumstances demonstrate grave urgency and warrant action.

Yet, when an ex parte action is taken, the authority taking the action is expected to do its homework to demonstrate the urgency and get its facts right to defend the action when challenged. Take the case of the 331 listed companies, which the capital market regulator was told — by none less than the Ministry of Company Affairs — were “shell companies”.

A shell company is one that is merely a shell — without substance in its operations and functions. The Securities and Exchange Board of India appears to have blindly taken the list it received and declared all these companies to be shell companies. Media reports suggest that some noteworthy names have been declared in one sweep to be “shells”. Declaring them to be shell companies, suggesting forensic audit of their existence and giving them pariah status on the stock market, where trades in them would be permitted only once a month, would cause serious injury to every holder of securities in these companies.

Some investors would have pledged their shares to lenders, who would determine such an event to be one of default. The underlying asset over which they had security would suddenly become illiquid. Others would have taken trading positions in these securities with a certain assessment of facts in; if they were suddenly told that regardless of facts, these companies deserved to be shunted to the periphery of the stock market, it would cause them serious losses.

Such a drastic action would, therefore, warrant giving notice to the parties concerned, giving them a chance to explain themselves. At the least, one would expect basic due diligence to be carried out before action were taken so that the (well-intentioned) objective of investor protection, far from being met, is not undermined. If a basic internet check would have shown that some of these are well-functioning, profit-making, loan-taking operating companies, the embarrassment of terming them “shells” could have been avoided.

The history of financial markets is replete with examples of such decisions. Ex parte orders purporting to be interim measures get passed and routinely become permanent measures. They are often known to continue for as long as five years.

Examples of every kind of sudden shock and surprise are now easily available. We have had securities being introduced into the derivatives segment in the middle of a month. We have had securities removed from derivatives in the middle of a month. Issuers of securities with derivatives riding on them, declaring record dates in the middle of a derivatives trading cycle, too have been seen.

Abnormal or extraordinary decisions invariably also point to the need to check if there was any abnormal pattern of trading just before they were announced. Often, that leads to probes and allegations of insider trading. In fact, a recent ex parte order froze every bank account of every individual named in it overnight, rendering them penniless. The suspicion in that order was that publicly known regulatory proceedings against a company had been the motive for every sale in listed securities of affiliates of that company.

Another type of development is in the risk of being repeated so often that it would become a trend. Relying on private “forensic reports” (often conducted by accounting and audit firms with little training in the rigours of investigative discipline), regulators take ex parte actions. Typically, these reports are riddled with disclaimers that render them poor evidence in law. However, in the post-truth world, by the time it can be demonstrated that there is no real legal evidence, the damage is done, and destruction of individuals and institutions is complete.

Is there a better way to handle this? Surely, if one asks oneself multiple times if the use of emergency powers to pass ex parte orders is warranted, the reckless usage of such a blunt weapon would get tempered. The value one attaches to the concept of the “rule of law” is best tested when the most provocative circumstances present themselves.

It is easy to adhere to the rule of law if one’s patience is not being tested to the brink. If one loses all vestiges of being circumspect and stops checking and regulating oneself, the rule of law would be replaced by the rule of men, risking the very credibility and majesty of law enforcement.

(This was published as a column titled Without Contempt in the Business Standard editions dated August 10, 2017. Disclosure: The author represents (after publication) for some companies affected by it.)

If news reports are right, the Securities and Exchange Board of India (Sebi) is coming full circle with collective investment schemes (CIS) and is seeking to “relinquish” the statutory mandate to regulate such schemes.

It was only in 1995 that the term found its way into the Sebi Act through an amendment to the list of market intermediaries that ought to be registered with Sebi to be able to carry on business in India. Then, too, Sebi had been a reluctant regulator. Schemes promising returns on the basis of plantations, animal farming, chain-marketing and the like mushroomed in the 1990s. The term “collective investment scheme” was not even defined in the Sebi Act. Therefore, despite the amendment to the Sebi Act, Sebi did not want to hold the CIS baby.

Public interest litigation, a plethora of complaints and a lot of angst later, the term got defined for the first time through an amendment in the Sebi Act in 1999. Sebi also made regulations in 1999, which, if reduced to one sentence, would have read: “No one shall operate a collective investment scheme”. The terms on which one could legitimately register and operate a CIS was akin to Christian states in the US stipulating norms for abortion agencies — keep the standards so rigid and tough that they pose an entry barrier and cannot be complied with. Not surprisingly, right since 1999, there has been only one reported registered CIS in the history of Sebi.

The problem with such an approach to regulation is fundamental — pretending that making it illegal to carry out an activity would put an end to it. The activity continued, the monies raised grew even faster, some of which are even feared to be from non-existent investors — read: money laundering schemes. An even more bizarre amendment sailed into the Sebi Act in 2013. The 1999 amendment had set out four ingredients to be met for any scheme or arrangement of affairs to be regarded as a CIS — essentially, schemes entailing a contribution of funds for earning of profits, management of the funds pooled by someone on behalf of the contributors and the contributors not having day-to-day control over managing the pool. Now, in 2013, the law was amended to say that even if these ingredients were absent, if the corpus of any arrangement of affairs was of Rs 100 crore or more, it would be “deemed to be” a CIS.

This set the cat among the pigeons. Any and every pooling of funds that would have a corpus value of Rs 100 crore would be a CIS, which meant that a registration with Sebi would be necessary for the activity to be legitimate. A pooling of resources by neighbours owning apartments in an expensive city like Mumbai to rebuild and redevelop their building would arguably be a CIS. The provision of holiday schemes where the contribution by guests would give them the right to use a property from the pool of properties built or rented with the contributions would arguably be a CIS. Provision of valuables such as gold coins with contributions in instalments would arguably be a CIS.

None of these would involve issuing securities and therefore, none of these can ever comply with the regulations governing CIS that Sebi had made in 1999. Therefore, all of it would be illegal. Those who cared for the law, shut down such activity or moulded them. Those who did not care, kept at it — eroding the majesty of the law even further by reason of formulation of law not properly thought through.

Meanwhile, with public furore over some CIS that failed led to some judicial comments about Sebi sleeping on its job, which got reported in the media and then led Sebi to crack down by ordering that monies collected be refunded within a few weeks or months. Now, this would spur asset-liability mismatches further and lead to either a run on the schemes that could not be met, or worse, led to CIS operators starting newer schemes underground to fund repayment of schemes ordered to be closed. In a nutshell, a royal mess is on the regulator’s hands.

It is in this context that reports of Sebi wanting to relinquish this statutory role is interesting. Around the time Sebi piloted legislative amendments to treat any corpus of Rs 100 crore or more as a CIS, it had a muscular tone about how anyone speaking about the need for a predictable framework for running a compliant CIS could only have been aligned with the bad guys. Now, it seems, Sebi is conscious that pushing an entire industry underground is actually counterproductive and brings about worse outcomes. Whether it would at all be politically possible to amend the Sebi Act yet again to remove CIS of this kind from Sebi’s ambit is doubtful. But one must assume that it the mind is set on an outcome, the government will find ways to get that done — whether through a Presidential Ordinance, a Money Bill or blanket provisions in the Finance Act.

If Sebi pulls off this one, the market would have come full circle back to the 1990s. Who then, would bell the cat?

This column was first published as Without Contempt in all editions of Business Standard edition dated May 5, 2017

Within Sebi, the chairman should hold an umbrella for both young and old employees

By Somasekhar Sundaresan

Very soon, Ajay Tyagi will take charge at the Securities and Exchange Board of India (Sebi) as the new chairman. The task requires calm reflection on the problems on hand, and a mind open to fresh ideas and innovative thinking. The capital markets regulator is at a crossroads. Never in the regulator’s history has this role been more complex than it is now. Here is a brief heads-up with pointers to what needs immediate attention.

First, Sebi is in crying need of a peacetime general. The very assumption of this office can make some incumbents believe that they are now at war with the big bad world of securities markets. As an institution, there is excessive focus on regulation of market conduct and lesser emphasis on prudential regulation. (The Reserve Bank of India is diametrically opposite in approach. Both need adjustment).

Never have Sebi’s statutory enforcement powers been more extreme. Contrary to popular belief, Sebi is armed with far greater power to inflict serious economic injury than counterparts in the US and the UK. Sebi needs to convince no judge before imposing serious restraints on economic activity. Routinely, this is done based on suspicion, leaving it to those affected to shoulder the burden of disproving the suspicion — somewhat like preventive detention. The check and balance is appellate review after Sebi has drawn blood. The onus is then on the person challenging Sebi’s conduct to show that it was wrong in taking action.

Sebi’s legislative powers, too, are near absolute. The Sebi Act grants wide discretion to Sebi to make subordinate legislation. Prior consultation with the market, a reasonable articulation of the link between the proposed solution and a problem statement, and a system of review of regulations to see if they have met the articulated purpose are substantially missing. There is indeed some form of selective public consultation but neither a statement of what problems are being sought to be solved nor a timely review of whether the solutions have indeed worked is mandated either by law or by a policy approach.

As a result, the fear of the regulator is widespread. With serious powers at hand, it takes maturity to structure the role into one of maintaining peace rather than of being ever ready to declare war. This is an attitudinal change that is necessary. Hundreds of inputs about the market being full of crooks necessitating a crackdown and severe intervention would be received. It would be easy to get carried away. Headlines screaming about the absence of powers or being toothless despite having powers would further an urge to lash out without thought. Eschewing a carpet-bombing approach and sifting the grain from the chaff are what the job at the top entails.

Second, the primary market regulation needs deep review and research as to what can be done better. The size of funds that get raised can never be a barometer of success for how this segment of the market regulation is performing. Securities offering documents are extraordinarily bulky, barely tell a story in clear terms and have substantially been reduced to bulky formal compliance rather than resulting in substantive disclosures of high quality. Cleaning up the policy space in this area of the market is a critical immediate objective to which the new chairman must apply himself.

Third, a review is overdue in the M&A space. It has been nearly six years since the “new” takeover regulations came into effect. Today, India is a unique jurisdiction where one body of law (takeover regulations) forces an acquirer to potentially cross the maximum limit of substantial shareholding permitted in a listed company while another body of law (listing conditions) forces the shareholding back down to compliance and a third body of law (delisting regulations) would need to be complied with if the intent was always to maximise shareholding and delist the company. Transaction costs mount, transaction timelines prolong unreasonably, defeating the very objective of mandating an exit opportunity by making an open offer for public shareholders to tender their shares.

Finally, Tyagi must give special attention to human resources and matters within the organisation. Too many junior officers have been tempted to be indecisive or to take wrong but safe decisions thanks to vigilance probes and hounding of honest bona fide decisions. Sebi is now well over 25 years old, and a full cadre of loyal employees is available at hand, despite the organisation having been the poaching ground for the private sector. Enthusing smart bright talent inside Sebi and leading them from the front to shield them from unfair targeting in criminal anti-corruption probes have to become a priority. Alignment and fitment of senior employees upon merger of the Forward Markets Commission into Sebi remains an open area of work. To begin with, Tyagi must ignore his own HR problem — his tenure was shrunk from five years to three even before he could take charge. As a seasoned bureaucrat, he would know that this the way of the government systems; there is nothing personal in it. But many in the organisation may not be seasoned in the ways of the government but would be highly talented in handling their regulatory work. Holding an umbrella for them and bringing in respect for punctuality and professionalism and rewarding them for it would help him create a legacy during his tenure.

This was published as my column titled Without Contempt in the Business Standard edition dated February 23, 2017

The securities market is running helter-skelter, regulator downwards. A short judgment of the Supreme Courtinterpreting the Securities and Exchange Board of India (Sebi) Act, 1992, has ruled that Sebi had no discretion at all in computing the quantum of monetary penalty for some violations between 2002 and 2014. Sebi is reported to have sought a review and a clarification from the court, and everyone in the market is waiting with bated breath.

The apex court’s order is an interpretation of carelessly drafted provisions in the Sebi Act that deal with imposition of monetary penalty for failure to furnish information. In 2002, the penalty for such failure (Section 15A) was changed from Rs 1.5 lakh for every failure to Rs 1 lakh per day of failure with a cap of Rs 1 crore. The language used was that a violator “shall be liable” to the stipulated penalty. In 2014, the same provision was amended to provide that the penalty “shall” be at least Rs 1 lakh but “may extend to” Rs 1 lakh per day of continuing non-compliance with a cap of Rs 1 crore.

The Supreme Court has ruled that between 2002 and 2014, there was no scope for Sebi to impose anything but Rs 1 lakh per day and where the violation continued for over a hundred days, the penalty would get capped at Rs 1 crore. Now, the process for imposing such penalties is through the initiation of “adjudication proceedings” under which an “adjudicating officer” adjudicates whether the violation alleged has indeed occurred, and whether the person accused of the violation has any valid defence. Once the occurrence of the violation is established, the officer proceeds to determine the penalty amount.

The Sebi Act provides for three objective criteria for determination of the penalty amount (Section 15J), namely, any unfair advantage or disproportionate gain made as a result of the default, the loss caused to any investor due to the default and the repetitive nature of the default. Disagreeing with Sebi’s plea that Section 15J shows legislative intent for discretion in assessing the quantum of penalty, the Supreme Court ruled that the provision had become redundant between 2002 and 2014, although it had not been repealed.

Now, let’s say the company secretary of a listed company who is in charge of filing a document under the listing requirements dies in an emergency and the company misses the deadline. The filing is forgotten and by the time the other officers get their act together, more than 100 days go by. If the adjudicating officer has no discretion at all, such a company would have to pay a penalty of Rs 1 crore without any gain being made, loss being caused, and even if the default were the first ever in its history. Another violator who deliberately disregards the filing obligation for the same period and complies only after coercive threats would be treated on a par with the former. According to the court’s judgment, all violations of this nature between 2002 and 2014 would enable no discretion at all to vary the penalty on the basis of the gravity of the facts. A person who deliberately defaulted would be treated on the same footing as a person who inadvertently defaulted.

There are numerous decisions of the Supreme Court that point to adopting a purposive interpretation of the law based on which the words “shall be liable” would mean “may be liable”. Indeed, the converse reading, too, would be possible by looking at the purpose of the legislation. Generally, no provision of law is lightly read as being redundant. All provisions are attempted to be read harmoniously to give the legislation its potentially intended meaning. This is how courts have read this provision for nearly 20 years, in a purposive manner, ruling that monetary penalties from Sebi would need to be fair, rational and equitable. They would test the quality of the discretion but not adopt the stance that discretion was absent.

The irony is that the observations of the court have come in a case where the court actually lowered the penalty originally imposed by Sebi. In the case before the court, there was a blatant violation in furnishing information sought by Sebi despite repeated reminders. Sebi imposed a penalty of Rs 1 crore against one person and Rs 75 lakh on five others. The Securities Appellate Tribunal had reduced the penalty to Rs 60,000 in one case and to Rs 15,000 each in five cases, taking into account the reality that the violators were near-bankrupt, had become dormant and were even left with no staff.

The court ruled that the tribunal could not have taken into account such factors. The court also ruled that the original date of the violation was prior to the 2002 amendments and that Sebi, too, was wrong in imposing a penalty of Rs 1 crore. The court reduced the penalties to Rs 1.5 lakh on each person, adopting the pre-2002 position of the law when the reference to non-disclosure being a continuing offence was absent.

Both Sebi and market players are stumped. The outcome of the fight over one case has laid down an interpretation of the law for all alleged violations that took place over this 12-year period – typical of uncertain outcomes for an entire market from litigation involving one case of violation.

The author is a partner of JSA, Advocates & Solicitors. Views expressed are his own. Email:somasekhar@jsalaw.com

Published in the Business Standard edition dated February 9, 2016: https://mail.google.com/mail/u/0/#inbox/152c457681ef8f5a?compose=152c5986c12e8714

SC’s rationale on validity of IT Act holds immense significance for the financial sector

The Supreme Court’s decision on a challenge to the Information Technology Act has made news for the section it outlawed — Section 66-A of that law. However, the court’s decision refusing to outlaw another provision of the law, and the rationale for that decision, carries immense significance and conveys serious lessons for the financial sector.

In the constitutional challenge to the law, Section 66-A was outlawed for being vague, over-reaching and arbitrary. However, Section 69-A (which empowers the central government to issue directions to block public access to electronic content) was saved as being constitutionally valid, on the ground that there were effective procedures and safeguards that could protect against abuse. Directions to block public access to electronic content under Section 69-A can be issued only on specific grounds, and Parliament also required the government to make rules to govern the procedures and safeguards for use of such power.

This is the section under which your access to viewing a documentary such as India’s Daughter can be blocked. Now before you jump to the conclusion that the decision to block that film has been upheld, remember that the court has only ruled that the power to block public access does not by itself violate the Indian Constitution. It does not mean that any and every use of that power is constitutionally valid. In fact, the court found that the safeguards and procedures enable a mechanism to avoid arbitrariness, and even after those are followed, a challenge under a writ petition can be made. Section 69-A explicitly reproduces the very eight grounds on which reasonable restrictions may be imposed on the fundamental rights to various liberties enshrined in Article 19 of the Indian Constitution. Written rules notified by the government specify that a request for blocking any electronic content has to be made to a “nodal officer” who shall apply his mind to whether or not any of the eight grounds are available in the facts of the case. She then puts up the complaint to a “designated officer” who is authorised to issue such an order. Meanwhile, a committee of government officers is required to examine the complaint, arrive at a view on whether the blocking of access may be considered to be reasonable (i.e. whether any of the eight grounds are available).

The committee is also required to give a hearing to any person who has generated or stored the electronic content sought to be blocked so that the arguments against a potential decision to block access can be heard. The case is then placed before the secretary, Ministry of Information and Broadcasting, who could then take a view, after which the designated officer may block access to the content complained of. Over and above this framework, a “Review Committee” is required to meet every two months and examine whether such decisions to block access to electronic content should be continued or not.

The Supreme Court took note of the elaborate framework of procedures and safeguards prescribed in law to protect against arbitrary usage of the power to issue directions, and therefore held 69-A to be constitutionally sound. Now, juxtapose this with a similar “power to issue directions” granted to the Securities and Exchange Board of India under sections 11(4) and 11B of the Securities and Exchange Board of India, 1992.

First, the sections themselves (unlike 69-A) make no reference to the safeguards set out in the Indian Constitution. They empower the regulator to issue directions “in the interests of” investors in the securities market – a term that can be understood in as wide a range as a painting of Mother India by M F Husain.

Using this power, any person associated with the securities market can be put out of the securities market until further notice without even a hearing. This measure can simply mean, in practical terms, that one cannot access one’s own savings invested in financial assets so long as such assets are “securities” — practically, almost everything other than what is in one’s bank account.

Second, unlike 69-A, there is no prescribed procedure at all for how the regulator should consider or reconsider whether directions under Sections 11 and 11B are warranted or justifiable. The need for a post-decisional hearing is often presented as a safeguard. In reality, in the absence of any prescribed procedure or timelines, there can be absolutely no expectation of when such a post-decisional hearing would be afforded.

It can range from a few weeks to several months. Instances of people being put out of the market on suspicion first, with investigations following later and dragging on for years, are par for the course.

In the 20-year history of this power, neither has a single rule been made by government nor has any regulation been made by Sebi on its own, to govern the usage of this all-important power similar to those in anti-terrorism laws.

Third, there is no review at all of whether a direction issued is required to be continued even when months and years go by. There is no review committee, no independent mind, or any other such safeguard to review whether or not a direction issued should be continued. Over the years, the norm has degenerated to the regulator almost never lifting a direction once issued.

Worse, the evidence shows that more and more strident tones are adopted regardless of content, in the delivery of the message continuing the directions. These tones prejudice “collective conscience”, which in turn, influences judges. So much so, that when directions are lifted by Sebi of its own accord, corruption is assumed. Provisions similar to sections 11(4) and 11B are contained in every legislation governing the financial sector — first found in the Banking Regulation Act and replicated in every legislation including recent ones such as those governing the insurance and pension regulators.

The Sebi is the regulator that has used it the most. None of these legislation has safeguards akin to those in 69-A. In the collective conscience of our society, the constitutional rights of those in business, have always been perceived as less worthy, perhaps due to the sub-conscious belief that these are the folks who otherwise subvert the law.

The European Court of Human Rights has recently seriously interdicted such powers of the Italian securities regulator. Until India brings order in this space, doing business in India will remain very difficult.

(The author is a partner of JSA, Advocates & Solicitors. The views expressed herein are his own.)

(This piece was published in the March 30, 2015 edition of Business Standard)